Exemption from Taxes on Eligible Stock Gains
QSBCs are similar to regular C corporations in terms of tax and legal aspects. A key difference is the eligibility of QSBC shareholders to potentially exclude 100% of their stock sale gains from federal income tax. This essentially means a 0% federal income tax rate on profits from QSBC stock sales. However, adherence to specific criteria in Section 1202 of the Internal Revenue Code is necessary, and not all stocks qualify as QSBC stock. There are also annual limits on the amount of tax-exempt stock sale gain, although these are unlikely to be a concern for most.
Importance of Stock Acquisition Date
The possibility of excluding 100% of federal income tax on gains only applies to QSBC shares bought on or after September 28, 2010.
If your business is currently a sole proprietorship, single-member LLC, partnership, or multi-member LLC, converting to a corporation and issuing shares is required to achieve QSBC status.
It’s crucial to carefully consider incorporating your business, and professional advice can guide you through the pros and cons of this decision.
Further Rules and Requirements:
- Eligibility: C corporations cannot avail of the gain exclusion for QSBC shares. However, individuals, LLCs, partnerships, and S corporations holding QSBC shares may be eligible.
- Holding Period: To qualify for the 100% stock sale gain exclusion, QSBC shares must be held for more than five years. For shares not yet issued, this exclusion is only available for sales after 2029.
- Share Acquisition: Shares must be acquired after August 10, 1993, typically at the original issuance, or through gift or inheritance.
- Ineligible Businesses: Certain service-oriented businesses, like health, law, engineering, and financial services, among others, do not qualify. Additionally, businesses centered around the reputation or skill of employees or involved in banking, insurance, or hospitality, are excluded.
- Asset Limits: The corporation’s gross assets must not exceed $50 million immediately after issuing shares. Exceeding this threshold later does not affect QSBC status.
Enhancements from 2017 Legislation
The Tax Cuts and Jobs Act fixed the corporate federal income tax rate at 21%. Thus, for profitable QSBCs, this might be the only income tax payable.
Incentives Dictate the Decision
Before deciding to operate as a QSBC, it's important to consult with professionals. We’ve highlighted key eligibility rules, but there are additional ones. The 100% gain exclusion on stock sales and the flat 21% corporate tax rate are significant motivators for suitable small businesses to consider QSBC status.